HEDGE FUNDS: The Japanese 'Widowmaker' Trade Is Finally Going To Work

In finance, the "Widowmaker" trade basically means one thing: Shorting Japanese Government Bonds (JGB) and inevitably losing money.

Because of Japan's gigantic national debt, and because the Japanese bond rally has gone on so long, investors have called the top in the Japanese bond market for years, only to get impaled.

The European sovereign debt crisis started getting people talking about Japanese debt some more, with Kyle Bass most famously devoting a substantial amount of money to short Japanese Government Bonds (this bet has faired very poorly so far).

Despite the setbacks, there's a new set of investors confident about shorting JGB, and this time they're armed with new explanations.

One has to do with the Japanese trade deficit.

Historically Japan has run trade surpluses, but now it's importing more than its exporting.

Via TradingEconomics, here's a long term look at Japan's trade balance. The change lately is clear.

The other reason people are hopeful about shorting JGB is the expected monetary policy regime change.

The likely winner of the December Japanese election is Shinzo Abe is a candidate who has run on a policy of explicit easting. Although he's backed off some of his most aggressive comments about the BOJ targeting 3%, it's clearly a big issue for him.

The key thing, however, is that if JGB decline due to a change in monetary policy, rather than a debt crisis, than it's really not a catastrophic event.

“We believe that things really are now set to shift,” says Christopher Rigg, a life-long Japan expert who runs a new dedicated Japan-short fund at UK-based activist Audley Capital. “We think it is all coming together now.”

Mr Rigg’s thesis is more moderate than Mr Bass’s: he says a catalyst for change will be the Japanese elections, set for December 16, which look set to usher in Shinzo Abe, head of the Liberal Democratic party, as prime minister.

“Abe is defined by his desire for growth,” Mr Rigg notes. “It’s quite obvious that he wants the Bank of Japan to be more aggressive.”

...

Mr Rigg expects such a development could push JGB yields as high as 2 per cent – nowhere near the 6 or 7 per cent catastrophists see but enough to make short sellers huge profits.

So the bottom line is that there's a new breed of widdowmaker bettors, but it's not based on estimates of expectations of a debt crisis, but rather growth and change at the BOJ. Note that while this chatter has picked up, and the yen has weakened, there's been a nice rally in the Nikkei... that's not something that happens when a market is fearing government collapse.